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A S&P recovery rating of ‘3’ (aka, an expected recovery in the range of 50-70%) is so much at odds with the price of the bond (currently trading low 40’s) as to reaffirm S&P own warnings that “credit ratings are [merely informed] opinions.”

The most direct trade on Patriot Coal’s troubles would have been to bypass the bond and to short the stock. A compromise play would have been a ‘married trade’ (i.e., long the bond and short the common) which, depending on the entry price of each leg, might have offered the chance to break even, or maybe even make a few bucks.

These are my own numbers: 10/13/11, bought one the 8.5 of '18 at 91.750 and 06/26/12, sold short 200 PCX (now PCXCQ) at 1.115. My expectation is an eventual workout for the bond in the range of 10-30 (aka, an S&P's rating of '5') and a decent profit on the short leg, meaning, I'll lose money overall but not as much as if I hadn't sold the stock short once it became obvious that the company was going to file Ch 11.

But the real profit on this trade, the thing that will make me money in the future, is that I gained a valuable lesson about how to set up these kinds of trades. In other words, this time, I was too early into the bond and too late into the stock for failing to track the things I should have been tracking if I'm going to mess with spec-grade bonds. I can't say that bad timing will never happen again, but at least I'll be able to minimize it.
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